225Research

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Market Analysis Our Picks

Energy Stocks- Dividend sustainability/growth for 4 High Payers

With many energy stocks trading at 52 week lows, it’s only fitting that yields have skyrocketed with the inverse relationship with yields rising as share prices fall. This means that investors have been able to get 7%+ yields everywhere in the sector, yet the market keeps pricing in further downside with terrible sentiment. In this report, we’ll go over these 4 company’s dividend, prospects, sustainability of the payout. These are all higher risk names and should be kept to small weightings within an underlying portfolio.

Vermilion- paying a monthly dividend of 23 cents, VET is currently yielding over 13%, displaying the market doesn’t believe the dividend is safe. However, the company has stated on many occasions, including recently after the last quarter (link) that the company has no plans of cutting its dividend. It’s important to keep in mind that this is a very experienced management team at doing right for shareholders, weather it be maintaining a solid balance sheet, realizing the benefit of growing production abroad, and sustaining the dividend in 2008/2016. Should management cut, it would lead to a distrust in the company, and management is well aware of this, meaning a cut seems unlikely should cash flows cover it.
The company is also likely aware that the dividend should provide valuation support (even if its still getting hammered along with the group), meaning that a drastic cut(below 6%), will disenfranchise its current investor base seeking income, likely meaning immediate selling pressure. However with the combination of a low decline rate, and high netbacks via higher pricing, the company can sustain production under $35/barrel. The company pays out around $10/barrel worth of dividends, meaning the company is breakeven on paying the dividend and sustaining capex at around $45/barrel.

Considering the low we reached for oil was $46 and quickly rebounded, the dividend looks should the commodity trade sideways. At $50+, the dividend is very sustainable even if sustaining capex creeps up a tad, as many think the company may be understanding the sustaining capex. At prices above $55, the company can fund some production growth, and cover the majority of their capital program. For the balance sheet, the company is around 2x debt to cash flow, so not overly debt ridden, yet not overly flexible should the company need to issue debt to just pay the dividend and maintenance capex (meaning very low oil price environment).

Verdict- the company won’t be raising the dividend again even with higher oil prices, yet remains unlikely we get a cut, barring prolonged low oil prices(below $45-40). Risk-reward looks very appealing especially at $55+ oil currently.

Torc- Currently Torc pays 2.5 cents/month(8%+), after raising the dividend from 2.2 cents a month a few months back. The fact that the company raised the dividend albeit while oil prices were over $60, shows the company believes in the cash flow generation of the company, at any oil price. The main appeal for the average investor is the fact that the CPPIB is a major investor with over 28% of the shares owned. This provides a mix of stability in the share base, and potential for additional access to funding for growth projects. It also means higher dividend sustainability, with CPPIB choosing to DRIP there shares, lowering overall payout (although raising shares outstanding) .
The company estimates that at $50 WTI, with average $9 spreads to the LSB price, the company just covers the maintenance capex and dividend, meaning prolonged weak pricing as well could cause a cut. However, the balance sheet is very strong(1x debt to cash flow), meaning the company could over-distribute as it waits for supply and demand to balance in the oil price.

Verdict- over the next year, as the company executes on their growth capex, with decent oil prices, a dividend raise could be in the cards. However, this looks far out. The dividend in the short term looks secure with the strong backing and balance sheet, offering investors a good opportunity to lock-in upside to oil prices and solid income.

Cardinal- the company pays an 8%+ yield after raising their monthly dividend by 50%. However the company did drastically cut the dividend in December. What has changed from than is the WCS spreads to WTI has closed, which impacted 40%+ of the companies production. The company is doing a lot of the right things in my mind- lowering production costs by spending to produce its own power, and cut G&A expenses. this will help the company maneuver through lower oil prices and the potential for spreads to weaken again. The weakening of WCS price to WTI is the biggest risk unlike many others on here, with its direct WCS exposure. The balance sheet is alright with less than 2x debt to cash flow, and the company has shown its prudent on protecting the balance sheet with the debt paydowns in lieu of growing production more. The company has one of the lowest decline rates, meaning with a low oil price environment that the company can put the remaining cash flow for the dividend, which the management has prioritized.

Verdict- the dividend looks safe currently, but should the differential start to drift, management has shown it doesn’t want to but will cut the dividend to protect the balance sheet. Dividend growth should be strong in a $60+ environment. Sub $50 long term we estimate with current spreads the dividend is 80% safe, partially because of its low decline, and cost cutting measures.

Whitecap- paying a monthly dividend of 2.85 cents(8%+ yield currently) and having just grown the dividend 6% a few months back, Whitecap’s dividend looks juicy. As it continues to creep up while the share price lingers, the market is signaling more and more that it may not be sustainable, like many dividend payers who the market sells off and leaves a big fat yield leftover. However, the fact that management was confident enough to raise the dividend is a good sign, as well as the company continues to buyback stock. If the company wasn’t overly confident in their ability to pay out, they would likely be reducing debt and funding the dividend with that cash. The balance sheet is fairly strong at 1.6x Debt/Ebitda, not as levered as peers such as Cardinal and Vermillion. This means the company can survive short periods with weaker oil prices. Also in the short term, the companies hedging program is in place for close to half of production, meaning cash flow variability should be rather secure. The company estimates that with $45 WTI, the company can cover the sustaining capex and the dividend, while having close to $20 million left over. Sure it’s possible that the company is understating maintenance capex, yet even with this margin for error it looks as if the dividend is safe in a weaker oil environment.

Verdict- Whitecap is one of our favorites and offers a big dividend that we think is safe for the next year and beyond. Over time if prices start to settle in the $60-70 oil range rather than the 50s, we could see more dividend increases, offering a solid risk reward.